Back in early December What They Think published my article Changing Priorities in What You Measure. In that article, we broached the idea that our industry, having gone through a lot of change due to digital technology and social media, needs to look at the ways we measure our businesses. We offered three metrics that need more attention than we’ve given them historically:

  • Value added per employee—This is the easiest way to measure total company productivity levels. There are some questions it helps to answer like:
    • What is the new productivity level we should see as we digitize our operations?
    • Will it be enough to drive the expected ROI?
    • If those investments don’t drive the needed improvement we are backing ourselves into a corner that is very difficult to get out of. This is a key metric and should be monitored monthly.
    • It helps to think about this measurement like this: Going forward into the future, revenue should grow at a faster rate than the rate of hiring new staff. Thinking about the present: Is the current level of staffing in line with the current sales level? If not, your profits are less than they should be.
  • The ratio: variable costs/ fixed overhead costs—Fixed costs have grown into a bigger impact on profits with maintenance agreements, software subscriptions, and higher paid expertise to support new technology, etc. This is of critical importance because, as your fixed costs grow to be larger than your variable costs, your breakeven point rises, making it harder to make a profit except at higher sales levels. The margin for error is getting smaller.
  • Product mix/capacity utilization

The article that followed the December posting was Dealing with Outliers. In it, we looked at a way of measuring the impacts of product mix. It starts with basic statistical analysis of various components of your mix, allowing a look at the profitability of jobs and customers as the components vary. The purpose is to make informed decisions about whether to continue to accept poor-fitting orders. This is important because accepting poor fitting work makes it even more difficult to remain profitable. Orders that take up large amounts of capacity and generate low margins are even less desirable in a higher fixed cost business.

In retrospect, after thinking about that article, I had an idea that might be a better approach to get you started looking at your product mix and how it impacts your business. It doesn’t require retooling your MIS system and taking months to get the pieces put together before you even start measuring anything.

To start with, let’s choose sales (or value added) per order as the first component of product mix we will evaluate. There are obviously other elements of product mix that describe your average order, but sales value per order is especially key to understanding mix and the profitability impacts of various types of orders.

Let’s also start by defining ideal customer as the type of customer whose needs for product types, service levels and pricing economics are an ideal fit with your talent, process and equipment mix. Look at your production process and decide what common characteristics your ideal average order should have. Having said that, it follows that ideal customers are those who primarily purchase your ideal order.

If I asked you the following series of questions, how would you answer them?

  1. What is your current average order size?
  2. What do you think is your ideal average order size? Be prepared. Your guess may be off the mark.

Here’s another set of questions:

  1. Who are your 3–5 most profitable customers?
  2. What are their average order sizes? Both, individually and as a group?
  3. Do the order types they buy from you fit the description of your ideal order? If they don’t, don’t panic. You may be enjoying a market advantage due to having no viable competitor who can offer what these customers buy from you.

Last questions:

  1. How close is the average order size of your most profitable customers to the average order size of the business as a whole?
  2. Looking at your outliers (more than +/- two standard deviations from the mean), what are their average order sizes?
  3. How do they rank in terms of profitability?

If you don’t have the data to help you answer these questions do the following:

  1. Take your last 30–40 jobs and add up their sales value in total.
  2. You should be doing this in a spreadsheet. Let the software calculate your mean and standard deviation. Let it next place each order in the proper group as outlined in the previous article, Dealing with Outliers (+/- one standard deviation, etc.).
  3. Now go back and answer the questions above.
  4. Next, if you want to, take the profitability of each of these last 30–40 jobs and create a spreadsheet just like the first one.
  5. Now you have a handy tool that can be used to answer all kinds of questions about your product mix and its impact on your profitability.

Once you have worked your way through this analysis you will have plenty to think about. Most importantly, you should have opportunities to improve profitability. These could come from:

  • Targeting a more desirable set of prospects to sell to;
  • Strategic decisions to disengage from customers who are poor fits for your company;
  • Profit improvements from acquiring better technology for doing the jobs your customers are buying from you;
  • The list goes on…

As always, if you have questions or would like to discuss the ideas in this article, please reach out to me at [email protected].